Mexico on the Brink

Mexico has the habit of disappointing both the extreme optimists and the pessimists. While its economy has repeatedly pulled back from the brink, any boom has been rather short-lived. The country has, as a result, muddled along a 3 percent growth path for many years now, signficantly lower than the emerging-market average of 6 percent over the last decade.

Now, even as many developing countries are again surging ahead after the global financial crisis, Mexico’s future is in doubt. Sure, the economy is showing its typical resilience and is on track to expand by 5 percent in 2010—a strong bounce back from the sharp 6.5 percent contraction last year due to the perfect storm of a U.S. recession and local factors such as the swine flu. But the key question is whether it is once again just a matter of time before growth settles back down to the mediocre 2.5 percent that the central bank estimates is the country’s default rate, or whether change is finally in the offing.

On the ground in Mexico City, where I traveled last week, it appears that things are at a tipping point. Aside from economic disappointment, a rapidly deteriorating security situation is precipitating the demand for change. The internecine warfare among Mexico’s drug cartels is spilling over onto the streets. Local media is saturated with stories about the sharp rise in homicides, and the country’s telenovelas are increasingly weaving in crime as a theme in their scripts. Surveys show that nearly half of all Mexicans have been victims of crime over the past year. There is growing recognition among policymakers that to improve governance and stem the violence, political reform needs to be at the top of the government’s agenda. For one, Mexico’s dysfunctional political system needs greater accountability. There are currently far too many legislators, with 128 senators and 500 representatives in the lower chamber, and more than a third of them nominated rather than directly elected. Reform proposals would reduce the number of legislators and allow them to run for reelection so voters can judge their performance. The hope is that once the political class has the right incentive system in place, the economic reforms needed to boost the country’s underlying growth rate will follow.

Serious political will is required to break the stranglehold of various public and private-sector monopolies that hobble Mexico’s growth. These monopolies produce about 40 percent of the goods that Mexicans consume. Phones services, soft drinks, and many foodstuffs cost more here than in neighboring America, where per capita income is five times higher. Relatively elevated prices of utilities such as electricity divert foreign investment to other countries in the region, despite Mexico’s natural advantage of its proximity to the U.S.

It is ironic that even though Mexico’s economy has underperformed the average developing country over the past decade, its stock market has significantly outperformed, in part because of the monopolies. Lack of much competition has allowed leading Mexican companies to generate higher rates of return on investment than their faster-growing emerging-market peers. The concentration of power in Mexico’s corporate sector is reflected by the fact that the top 10 Mexican families account for more than a third of its market capitalization—among the highest for any emerging market.

Mexico is a leading example of a country unable to break out of its middle-income existence; the will to reform sags once the economy moves beyond a subsistence level. Even as the call for change is rising in Mexico, different constituencies are fighting over each reform proposal. Public-sector unions are staunchly opposing liberalization of energy, electricity, and education while some leading private companies are obviously not eager to increase competition that will threaten juicy margins in their respective sectors.

All this means that change, when it comes, will likely be incremental. But what’s important is that momentum has begun to swing in the right direction, which is a real positive compared with some of the prevailing emerging-market stars, where success is breeding complacency. After a lost decade, which saw countries from Chile to Brazil overtake Mexico in the per capita income league tables, reality is finally dawning upon Mexico.